China Cheat Sheet Helps Investors Survive: Ben Simpfendorfer

Sept. 2 (Bloomberg) -- Ten years ago, China barely
registered on global financial markets. Today, it is front and
center. Yet, the market’s understanding of the world’s second-largest economy has struggled to catch up. It is big, foreign,
and suffers from a serious lack of economic data, meaning
speculation can be as important as fact.

So here are five simple points that go a long way to
understanding one of the world’s most complex places:

First, China doesn’t publish gross-domestic-product data in
the same way as other countries. It publishes a growth rate, but
no quarterly breakdown of real demand. It is one of two Asian
nations that don’t publish such data. The other one is Laos.

This is a problem. National-accounts data is an economist’s
most important tool. It shows how much consumers have spent on
food, or companies have spent building factories. It is the
breakdown that helps us understand if the composition of growth
is healthy or reliant on just a few sources of demand.

In the case of China, there is a risk the country is
spending too much on building highways and factories, resulting
in overcapacity and bad debts. And since there is no reliable
quarterly data on such investment spending, it is hard to
understand whether last year’s rocket-fuelled recovery has only
worsened imbalances.

So when third-quarter growth figures are released in early
October, it’s worth attaching a health warning to the report.

Second, food almost always explains surprise changes in the
consumer-price index. Part of the problem is that the average
Chinese household is more likely to purchase fresh food to be
cooked at home. By contrast, in neighboring Hong Kong, food
eaten in restaurants accounts for half of the food sub-index, so
labor and rental costs help to damp the impact of a sudden
increase in fresh-food prices. Not so in China, where fresh-pork
prices alone, for instance, can visibly shift the CPI.

The upshot is that the country’s weather patterns, rather
than its economic cycle, are arguably more important in
forecasting the CPI.

Third, China’s domestic demand provides less support to the
global economy than popularly believed. Its imports have surged
in the past decade, but it’s important to understand what
exactly the country is buying.

About a third of imports are destined for the re-export
trade. Chinese factories buy semi-conductors and mother boards
from producers in Singapore and Taiwan, for instance, assembling
them into notebook personal computers, and then shipping the
finished good to retail shops in the U.S. and Europe.

Almost another third is commodities. China accounts for
much of the world’s demand for many raw materials and is the
main buyer of iron ore. Its commodity imports benefit countries
such as Australia, Brazil, Chile and South Africa, even as this
trade inflates prices for other importers.

The final third is made up of goods such as turbines from
Germany, excavators from Japan, and aircraft from the U.S. These
are the real drivers of global growth. Yet, such imports were
valued at only $430 billion in 2009. To put that into
perspective, Korea’s imports were worth $320 billion in the same
year -- not much less.

Fourth, China is big, but poor. Its per-capita GDP is
$6,600, as measured by purchasing power parity. Yet, this still
ranks China alongside Algeria and Namibia in terms of wealth.

Moreover, much of the country’s growth has so far benefited
companies, rather than households. That’s one of the downsides
of a low-cost business model. Exports and corporate profits have
surged, but low wages have generally depressed private
consumption and created social stresses.

It’s no surprise then that the government is now
aggressively trying to address these imbalances, by lifting
minimum wages and improving working conditions. The focus on
raising wages and preventing job losses is one reason China has
yet to revalue its currency, as critics have demanded, and why
it is likely to resist such calls in the future.

Fifth, structural-growth drivers are as important as
cyclical ones. The liberalization of China’s housing industry in
1998, for instance, explains much of the country’s surging
growth. Until then, the state provided most of the housing
stock. But reforms allowed households to buy bigger and better
homes, and property developers built them.

It might be that the structural drivers are now being
overwhelmed by cyclical ones and that China is experiencing a
housing bubble no different from those of the U.K. and U.S. If
so, the bears will soon be proven right as the bubble bursts and
China’s decade-long boom will be brought to a screeching halt.
But if the bears are proven wrong, it will be because of the
emergence of new structural drivers.

Urbanization is one such driver. Some analysts say China’s
urban population will grow by 15 million people annually over
the next 10 years, implying an extra 5 million apartments
annually -- a huge source of demand.

Services are another. China’s manufacturing is still the
largest driver of growth, but there are the early signs of an
emerging services sector, from car rental to cinema multiplexes.

These five points are by no way exhaustive. But China is
unusual compared with many of the world’s largest economies,
perhaps because of the country’s status as a developing, Asian,
or formerly planned economy. The usual set of analytical tools
won’t always apply, however tempting it is to do so.

(Ben Simpfendorfer is the chief China economist at Royal
Bank of Scotland Group Plc in Hong Kong and the author of “The
New Silk Road.” The opinions expressed are his own.)